When is £1m not £1m?

Canada Life offers a range of wealth management solutions, including retirement income planning, estate planning and investment solutions from a choice of jurisdictions, including the UK, Isle of Man and Republic of Ireland.

The residential nil-rate band (RNRB) was first announced in 2015 and will be available from 6 April 2017. Initially set at £100,000, it will increase by £25,000 each year until it reaches £175,000 in April 2020.

The standard nil-rate band is frozen until April 2021, after which both bands will increase in line with CPI. This means that, in the 2020/21 tax year, each individual will be able to pass on up to £500,000 and a married couple or civil partners up to £1m. Will everyone be able to benefit from this?

The RNRB is available only on death so cannot be used for lifetime gifting and, as you would expect, comes with conditions. So let us consider some of the key points around the RNRB, when it is available and when it may not be available.

Qualifying residential interest

The RNRB is available only to those who held a ‘qualifying residential interest’ immediately before death. They must have owned all or part of the property at the time of death and this property must have been their residence, but not necessarily their main residence. Therefore ownership of an investment property is not a qualifying interest.

Those who have released equity will be affected as it is the net value of the home that will be used; any outstanding loan against the property will have to be deducted first.

Any individuals who do not own their home will be unable to utilise the RNRB as they will not have a qualifying residential interest. However, there are provisions for those who have sold a property; for example, where the deceased owned a property after 7 July 2015 that was subsequently sold or downsized because they were moving into residential care.

Lineal descendants

The property, or cash if the deceased downsized, needs to be ‘closely inherited’; passing to lineal descendants such as children or grandchildren, including adopted children, stepchildren, fostered children and those under guardianship. A spouse, surviving spouse or surviving civil partner of a lineal descendant, who has not remarried by the time of the property owner’s death, is also included.

If there are no lineal descendants, the RNRB will not be available.

Transferring unused allowance

Similar to the standard inheritance tax nil-rate band, any unused RNRB can be transferred between spouses and civil partners and must be claimed within two years from the end of the month in which the second death occurs.

Where the first death occurs before April 2017, an unused RNRB of 100 per cent will be deemed to be available when the surviving spouse or civil partner subsequently dies, regardless of whether the first to die owned a qualifying residential interest.

Large estates

There is also a ‘taper threshold’ for large estates, which is initially set at £2m, reducing the RNRB by £1 for every £2 over the threshold. So, when the RNRB is introduced at its initial level of £100,000, an estate of £2.2m or higher will mean there will be no RNRB available. This rises to £2.35m for the 2020/21 tax year when the RNRB is £175,000. This doesn’t account for any transferable RNRB to which the deceased’s estate may be entitled.

When valuing the estate, it is the net value of the assets held on death. It does not include lifetime gifts previously made by the deceased, nor make allowance for any reliefs such as business property relief or agricultural property relief that may be available.

Example

To help explain the RNRB, let us consider an example:

Eric dies in May 2017 leaving a wife, Joan, and their son, Arthur. The family home is valued at £400,000 and other assets total £600,000, all being held jointly between Eric and Joan.

Eric leaves everything to Joan

The spousal exemption applies, meaning that ownership of the family home and other assets passes to Joan without any IHT being due, and Eric’s standard NRB and RNRB are unused

Subsequently, in June 2020, Joan dies and leaves her estate to Arthur. The house has increased in value to £600,000 and the other assets to £800,000, giving a total estate of £1.4m.

Joan’s executors can use her NRB of £325,000 and, as she owns a qualifying residential interest on death, the RNRB of £175,000. As Eric left everything to Joan, her executors can claim his unused NRB and RNRB.

Joan’s estate can therefore benefit from a total of £1m in NRBs: 2 x £325,000 and 2 x £175,000.

If the value of the house had been less than £350,000 at the time of Joan’s death, the total amount of RNRB available to Joan would have been limited to the value of the house.

After allowing for the available NRBs, the residual value of the estate of £400,000 and IHT of 40 per cent mean a tax liability of £160,000.

But what if Eric had utilised his RNRB when he died?

Eric left his share of the family home, which was held as tenants in common, to Arthur using his RNRB of £100,000 and £100,000 of his standard NRB. Joan therefore received the other assets, using the spouse exemption.

On Joan’s death, Eric’s RNRB and part of his standard NRB have been used, but her executors can claim £225,000 as Eric’s unused NRB.

Joan’s estate consists of one half of the family home, now worth £300,000, along with the other assets, now valued at £800,000, totalling £1,100,000.

A tax liability of 40 per cent exists on £1,100,000 less £725,000 = £375,000, meaning that £150,000 is payable in IHT.

The £1m NRB may sound like a great thing and for the right client it will provide valuable IHT benefits, but not everyone will be able to take advantage of it. In addition, not only are IHT receipts expected to increase, even after taking into account the RNRB, but the number of estates suffering IHT is also expected to increase.

Tax planning and professional advice will be vital to ensure that estates and wills are structured in the most tax-efficient way and that clients understand the amount of NRB that will be available in their specific circumstances.

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